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Who Says You Can’t Mix Water and Gas?
Over more than 130 years, Aqua America (NYSE: WTR) has grown to become a leader in the water and wastewater utility industry, serving more than three million people across eight states. With the acquisition of the Pittsburgh-based natural gas distribution company, Peoples, Aqua is building on its expertise in infrastructure investment, regulatory compliance and operational excellence with a new platform for growth. With complementary service territories focused primarily in Pennsylvania and a long history of service to their communities as regulated utilities, the two companies are a strong fit that will provide many compelling opportunities for growth and investment. The Peoples acquisition puts Aqua in a strong position to continue to deliver shareholder value while also serving the company’s mission of improving the lives of customers through investing in infrastructure for safe and reliable service.
- Acquisition of Peoples natural gas utility adds more than 740,000 customers and increases rate base by nearly 50%
- Delivered 73 consecutive years of dividend payments and 28 dividend increases in the last 27 years
- Plans to invest more than $500 million in improving water and wastewater infrastructure in 2018
- Resulting company will be approximately 70% water and 30% gas and maintain strong municipal water and wastewater acquisition strategy
Advisor Access spoke with Aqua America CEO Chris Franklin.
Advisor Access: Please describe Aqua America and what led the company, after more than 130 years of successful growth as a regulated water utility, to decide to expand into natural gas distribution?
Chris Franklin: To understand the rationale behind our transformative acquisition of Peoples, a natural gas distribution utility based in Pittsburgh with more than 740,000 customers, I think it’s helpful to provide some context around Aqua, our industry, and our history of growth.
The vast majority of our nation’s population is served by disparate municipal water and wastewater systems, and many of these systems are deteriorating and in dire need of investment. As cities and towns struggle to maintain their water systems’ infrastructure, compliance requirements and service quality, Aqua is providing a solution. We have the expertise and capital to improve the safety and reliability of water systems. In fact, we plan to invest approximately $1.4 billion in infrastructure improvements through 2020.
Additionally, Aqua has acquired over 300 systems over the last 20 years, consolidating small and midsize private and municipal systems and leveraging our expertise, process efficiencies, and access to capital.
While the acquisition of municipal water and wastewater systems is a solid growth strategy, it takes time to build relationships, earn trust and provide education about the benefits of these solutions. Because of this, our leadership team set out to evaluate supplementary platforms for growth that could build on our deep expertise in infrastructure and utility service. We found the natural gas distribution business integrates many of our existing core competencies. Both water and natural gas companies use the same regulatory process for rates, and both spend a vast portion of their capital each year on pipe and main replacement.
Peoples is a remarkably good fit for Aqua. Both Aqua and Peoples have more than 130 years of service and proven track records of operational efficiency and regulatory compliance. Both have complementary service territories focused primarily in Pennsylvania, one of the most constructive regulatory states in the country. We are very excited to welcome Peoples to the Aqua family because it adds a significant new platform for growth and expansion, and will enhance our mission of improving infrastructure and quality of life in the communities we serve. The combined company will serve more than 5 million people and increase our rate base by nearly 50% to $7.2 billion in 2019. Rate base for the water business will grow at 7% per year, and rate base for the gas business will grow at 8-10% per year.
AA: What is it about Peoples’ location in western Pennsylvania that makes the company particularly attractive to Aqua?
CF: The vast majority of Peoples’ operations, and 77% of the combined company’s rate base, is in Pennsylvania. Peoples also operates in Kentucky and West Virginia, but this focus on Pennsylvania is a key feature of the acquisition because of the state’s constructive regulatory environment. Aqua pioneered the Distribution System Improvement Charge mechanism in Pennsylvania that allows utilities to recover capital expenditures between base rate cases. Similar legislation has spread to other states and industries.
Peoples’ location is also beneficial because the company’s service area sits on top of the Marcellus Shale, one of the largest natural gas deposits in the world. While Peoples is not involved in exploration or drilling for natural gas, by sourcing the gas locally, Peoples, and ultimately customers, have lower costs.
Peoples is headquartered in Pittsburgh, a growing and dynamic city where abundant, low-cost energy is jumpstarting manufacturing and other industries. There’s also a strong technology, medical and educational presence in the region.
Additionally, Peoples has made proposals to provide a solution to the city of Pittsburgh’s troubled water system and, though this was not the rationale for the acquisition, Aqua welcomes the opportunity to be involved in solving Pittsburgh’s water challenges.
AA: What opportunities for infrastructure investment and regulatory mechanisms does Peoples have? Are they similar to Aqua’s opportunities in water?
CF: Aqua has an incredible record of replacing hundreds of miles of main for service reliability, which strengthens communities and increases our rate base. Peoples has significant opportunities for similar investments, which will increase the safety and reliability of the company’s natural gas infrastructure as well as grow rate base. The company has identified over 3,000 miles of mains to be replaced by 2034 in Pennsylvania alone. Peoples plans to replace approximately 150 miles of pipe per year, and to substantially increase overall capital spending of the next several years. Approximately 70 percent of Peoples’ capital expense is covered by the Distribution System Improvement Charge or similar mechanisms, which allows more timely return of capital outside of rate cases. We pioneered this mechanism over 20 years ago and utilize it in the water business.
Another significant opportunity for growth and investment is to expand service into rural areas of Pennsylvania, where customers are currently served by more expensive energy sources such as oil, propane, and electricity. Peoples is targeting approximately 370,000 potential customer conversions over time. According to the American Gas Association, households using natural gas save an average of $874 per year compared to electricity.
AA: Will the Peoples acquisition have any impact on Aqua’s long-standing policy of paying increasing dividends?
CF: Nearly half of Aqua’s stock is owned by retail shareholders, and many of these investors value our long history of paying dividends. In fact, Aqua is among an elite group of dividend payers known as “Dividend Aristocrats” that have increased payments for more than 25 years in a row. Our most recent increase of 7% was the 28th in 27 years. Aqua has paid a quarterly dividend for 73 consecutive years.
The Peoples acquisition will increase our long-term earnings potential and our ability to continue to maintain a strong dividend growth rate. Our dividend payout ratio target remains in the 60-70% range.
AA: This year Aqua has announced several new municipal acquisitions and purchase agreements. What is behind this uptick in new deals and do you expect it to continue after the Peoples acquisition?
CF: Aqua really values the trust elected officials and other decision-makers put in us when they turn over their responsibilities for their water and wastewater systems. We recently closed two municipal acquisitions in Illinois and one in Pennsylvania totaling over 12,000 new customers, and have a pipeline of seven additional signed asset purchase agreements for water and wastewater systems with approximately 21,000 customers. This totals nearly 33,000 new customers, and over $200 million in rate base. We expect these closed acquisitions, when added to organic growth, will increase our customer base between 2-3% in 2018. We also recently reached the significant milestone of one million customer connections.
This uptick in acquisitions is largely a result of new “fair market value legislation.” This legislation allows companies like Aqua to pay and earn a return on the full market value of its acquired water or wastewater assets. Previously, in most states, only the depreciated original cost of the acquired assets was included in rate base. We are now able to pay a price that assigns an appropriate value to the municipalities’ assets and gives them greater incentive to sell. With this legislation in six of Aqua’s states, we are confident we will be able to provide a solution to many more communities whose municipal water or wastewater systems are in need of investment.
Fair market value is a relatively recent development, and it continues to spread with laws passed in Illinois and North Carolina this year, and additional legislation in progress in Ohio. We believe it will be a significant catalyst for our growth strategy for many years to come.
AA: What key takeaways would you like investors to know about Aqua America?
CF: We are a more than 130-year-old company providing essential services, operating as a nearly 100% regulated business, and paying a steady, growing dividend. The leadership team is focused on delivering shareholder value. All of this gives our company a stable, defensive quality.